The Economic Policy Uncertainty Impact on Firms’ Capital Structure Evidence from Consumer Services Sector in Sri Lanka

Abstract

Introduction: This study investigates the impact of Economic Policy Uncertainty (EPU) on the capital structure decisions of consumer services firms listed on the Colombo Stock Exchange in Sri Lanka. Specifically, it examines (1) the relationship between EPU and market leverage (ML), and (2) the effect of EPU on book leverage (BL).

Methodology: Utilizing a quantitative research approach, the analysis is based on panel data from 2014 to 2023. The study covers 10 consumer service companies in Sri Lanka over a ten-year period. EPU data was collected from the EPU index scores provided by the World Bank, while other variables were gathered from audited annual reports and DataStream.

Findings: The findings reveal a significant negative relationship between EPU and both ML and BL, suggesting that heightened economic uncertainty prompts firms to adopt more conservative financial strategies. Among the control variables, firm size shows a positive correlation with leverage, indicating that larger firms are better positioned to access debt markets. Profitability, on the other hand, has a negative relationship with leverage, as more profitable firms tend to rely on internal financing. Other variables, including tangibility, EBIT, GDP, and board size, exhibit limited or no significant influence on leverage decisions in the context of high EPU.

Conclusion: These findings underscore the critical role of EPU in shaping corporate financial strategies and highlight the continued relevance of firm-specific factors. When economic policy uncertainty rises, companies tend to reduce borrowing, resulting in lower market and book leverage. Policymakers should aim to create a stable economic environment and enforce transparent risk disclosure practices to enhance market resilience. Meanwhile, firms should implement robust financial strategies to navigate uncertainty effectively, and investors may prefer companies with lower debt exposure during volatile periods.